Have you ever heard of the saying ‘Don’t put all your eggs in one basket.’? As early as first grade, I would hear this saying every now and then, but it wasn’t until I started working that I understood just what it really meant – to my finances. The children of my generation and older grew up on the belief that if you study hard, you get a good job. If you get a good job, you get paid well. And when you get paid well, you get to save more. And the best place to save your money is in the bank. Because your money is safe and earns interest. Back in the 80’s and early 90’s, interest rates were in the double digits. So putting money in the bank then seemed the right thing to do, and to some degree, it still is today.
My grandmother invested her money in only 2 places – her bank’s 30-day term time deposit and real estate. And in those days, it was ok. Interest rates were high and everyone wanted property. But can you do that today? Sure you can, but you need to take it a few steps further. And to do this we need to diversify our investments.
What is diversification? It basically is just what the saying states – not putting all your eggs in one basket. It means you shouldn’t put all your money in only one type of instrument. It’s a way to manage risk to ensure that your financial goals are reasonably and efficiently realized.
Why is diversification so critical these days? With the fluctuation of market indicators such as saving vs borrowing rates, GDP, remittances, foreign direct investments, inflation, or exports (and many others), there is no way to predict with certainty how one instrument will do. These days, interest rates in ordinary savings accounts are less than 1%. If you put all your money in a savings account, you earn less than the already less than 1% because of the 20% withholding tax.
And what if inflation is at 3%? Would you have earned, or would you have lost? (Inflation is the general increase in the price of goods and services.) Savings interest gives your money the chance to earn, while inflation decreases its value. So if your savings interest earns you 1% but inflation is at 3%, your money would have lost a net value of 2%. You would have been better off spending it rather than saving it!
So making diversification part of your investment strategy helps combat the effects of inflation. How? Basically, if you put your money in different instruments that earn different rates of return, the likelihood of your money losing value under one investment is not only offset by the likelihood of your money gaining value in another but having a real shot at returns! Sounds complicated? Just see the table below as an illustration of how diversification works.
How do you begin your diversification strategy?
OFW Coach Tip #1: DEFINE YOUR FINANCIAL GOALS. Before you even choose your investment instruments, you must first determine why you need to save or invest. What are your goals? Goals need to be CLEAR. CLEAR stands for Concise (it has to be comprehensive but short so it’s easy to remember), Logical (it needs to make sense! Having a car only you can touch when you don’t drive is a waste of resources), has an Ending (goals must have deadlines), Ambitious (it should be just out of reach to make you work harder for it) and Rewarding (it should make you feel good once you’ve attained it).
OFW Coach Tip #2: KNOW WHERE YOU STAND. Just how much money can you invest and set aside to attain your goals? To find out, you must do a little bit of household accounting. What are your sources of income versus your expenses. Is there anything left? Or do your expenses outweigh your income? For this exercise you will need to fill up an Income Statement. Another useful exercise is to determine your Net Worth. It’s basically listing down all your assets (things of value) and your liabilities (things that take away value) and comparing them to each other. A negative net worth means you are in debt, and the first rule is to get out of it – fast! Knowing where you stand gives you confidence to take action. But before you do…
OFW Coach Tip #3: FIND OUT HOW MUCH RISK YOU CAN HANDLE. Risk is a subjective concept – it differs from person to person, and may be different today than what it was a few years ago. To know what your level of risk you are willing to take on today, you can go to any website offering risk tolerance quizzes or tests, such as this. Just remember that the outcome of an assessment is merely a guide – in the end, the decision rests solely on you. Knowing your risk preference will lead to confident choices, and better sleep at night!
OFW Coach Tip #4: LEARN YOUR OPTIONS. Now that you know the level of risk you are willing to take, you need to find out what instruments there are to match it. There are plenty to choose from! Mutual Funds, Unit-Investment Trust Funds, Stocks/Equities, Bonds, etc. All these, and more, have their corresponding historical rates of return, recommended investment timeframes and company information on those who issue them – you’ll need to read and understand all these so you can find the best ones you are most comfortable investing in.
OFW Coach Tip #5: ACT NOW, BUT BE PATIENT. All we’ve been talking about will be for naught if you don’t take action, today! It’s easier said than done but, just like with anything else in this world, if you feel it’s worth pursuing, do it now before the feeling fades away. Too often people find excuses not to do something, and they only end up hurting themselves more. So do yourself, and your finances a favor – once you’ve gone through tips 1 to 4, do tip 5 as soon as possible. And for tip 5 to be a success, you need patience. Don’t get flustered by the ups and downs of your earnings and losses – it’s all part of investing. And if you’re truly in it for the long haul, the end result should get you closer to meeting your goals.
Diversification is just one of the investment strategies you can put into practice. Visit ofwcoach.com weekly for tips and information to empower you to come home, for good. Subscribe to my mailing list to get updates straight to your mailbox, and feel free to check out the tools section for useful resources. If you have a personal OFW experience you’d like to share, write me at firstname.lastname@example.org. I would love to hear from you! Coach signing off until next time!